Earnings Call Transcript - REFI Q4 2021

Operator, Operator

Thank you for standing by and welcome to Chicago Atlantic Real Estate Finance, Fourth Quarter 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the presentation, there will be a question-and-answer session. I would now like to hand the conference over to Tripp Sullivan of Investor Relations. The floor is yours.

Tripp Sullivan, Investor Relations

Thank you, good morning. Welcome to the Chicago Atlantic Real Estate Finance conference call to review the company's results for the fourth quarter of 2021. On the call today will be John Mazarakis, Executive Chairman; Tony Cappell, Chief Executive Officer; Andreas Bodmeier, Co-President and Chief Investment Officer; and Lindsay Menze, Chief Financial Officer. Our results were released this morning in our earnings press release which can be found on the Investor Relations section of our website along with our supplemental filed with the SEC. A replay of this call will be available shortly after the conclusion of the call through March 29, 2022. The numbers to access the replay are provided in the earnings press release. For those who listen to the replay of this call, we remind you that the remarks made herein are as of today, March 22, 2022 and will not be updated subsequent to this call. During this call, certain comments and statements we make may be deemed forward-looking statements within the meaning prescribed by the securities laws including statements related to the future performance of our portfolio, our pipeline of potential loans and other investments, future dividends and financing activities. All forward-looking statements represent Chicago Atlantic's judgment as of the date of this conference call and are subject to risk and uncertainties that can cause actual results to differ materially from our current expectations. Investors are urged to carefully review various disclosures made by the company including the risks and other information disclosed in the Company's filings with the SEC. We will also discuss certain non-GAAP measures including, but not limited to the distributable earnings and adjusted distributable earnings. Definitions of these non-GAAP measures and the reconciliations to the most comparable GAAP measures are included in our filings with the SEC. I'll now turn the call over to John Mazarakis. Please go ahead.

John Mazarakis, Executive Chairman

Thanks Tripp. Good morning everyone and thank you for joining us today. As this is our first earnings call since completing the IPO in early December, I would like to welcome all of our new shareholders and analysts. We have worked hard to get to this point, and we're excited about the opportunities ahead of us. With less than a month between our IPO and the end of the fourth quarter, the real measure of our strong start is in the growth of our portfolio, the attractive yields we're generating, and the robust pipeline of new loan originations. We will focus much of our time this morning on each of these topics, as well as the state of the industry and our capital structure plans. Before we do that, I want to highlight some of our financial results for the quarter and to date in March. We have been growing our loan commitments since the inception of the REIT in Q2 2021 where we had $72 million in commitments. That number grew to $192 million at IPO and $235 million at the end of 2021. As of March 17, we have $324 million in commitments. Since the IPO and through March 17, we have funded $115 million of new and existing commitments, deploying all IPO proceeds, which puts us ahead of schedule in doing so and beginning to draw on our revolving credit facility. With this portfolio growth, we reported $0.57 of earnings and $0.61 of adjusted distributable earnings for Q4. The fourth quarter results and the active start to the year also enabled the Board to declare a $0.26 dividend in Q4 and subsequently increase it in Q1 by 54% to $0.40 per share. Now, let's talk about what initially attracted us to the cannabis market. Four years ago, we recognized that there was an opportunity to bring an institutional lending approach to an industry that had previously struggled to access capital. By institutional approach, I mean introducing to the nascent cannabis industry, the disciplines that are taken for granted in all of direct lending, such as rigorous credit reviews, strict underwriting guidelines, deep operator evaluations, enterprise value analysis, as well as other methods of perfecting collateral. We were not looking to create a new model of lending. Instead, we just focused on applying what has been a tried and true approach to an industry that desperately needed it. With a little over $1 billion in closed facilities, most of which have been in cannabis, we've established a good track record and capitalized on being a first mover in this space. The fact is, you can't create a track record like this without having a good team, and we have one of the best teams in the industry. Tony has been in banking for over 15 years, and he has completed over $5 billion in loans during his career at Wells Fargo and SteelGate Capital. Andreas has underwritten over $500 million in cannabis credit transactions and heads up our investment efforts. He has a strong research and consulting background that helps us with risk management. Peter led the cannabis lending practice at BC Partners Credit before joining us and has a strong underwriting background as well. I come from an operating background having built businesses from the ground up as a real estate developer and owner. We have a diverse, yet complementary background, backed by a team of over 30 investment and management professionals who have helped establish the Chicago Atlantic brand in the cannabis industry. I'm focused on ensuring we have the right people in place, the right culture, full integration of the REIT with the Chicago Atlantic originations platform, and my goal is to continue building on our well-earned reputation as a trusted capital provider and to grow together with the leading operators in the industry. Another feature that attracted us to the cannabis industry is that it is by no means mature. I've described it before as being in maybe the second inning in terms of its development. In an industry like this, sometimes it's hard to accurately estimate how big the addressable market really is. We and others in the industry have estimated the current size of the legal state regulated markets as $25 billion in top line retail revenue, and a multiple of that across the entire value chain. I think we all know it is much larger when you factor in the illicit market, which will eventually become legal over time. When you adjust for that inevitable transition, we believe it is really a $100 billion industry just on the retail side. We have stats in our presentation that highlight the industry could rival beer, spirits, and wine by 2030, leading to substantial growth opportunities and demand for capital. This industry is not the Wild West anymore. The real winners will be the operators that have a proven and disciplined approach, the operators that understand unit economics, scale of manufacturing, and multi-unit retail operations. As Andreas will explain later, when we look at the opportunities in our pipeline, we can quickly identify the operators who meet our stringent criteria, and those that likely never will. We believe that good operators will be rewarded long-term, and there will be a shakeout. As we look across our portfolio, it's clear where we are focused on providing capital. We have primarily targeted the limited license states with operators that are vertically integrated. While we're open to opportunities west of the Mississippi, we prefer to start with states that are medically licensed and then grow within them as many of those states transition to adult use. The regulatory environment is one of the biggest hurdles in this industry, and we are very familiar with the dynamics within each state and what is being proposed. While federal legalization, the passage of the Safe Banking Act, and a change in the Internal Revenue Code to Section 280E will ultimately unlock the true potential of this market. Our opportunity set is not built on any of these events occurring in the near term. After the Biden-Harris administration took office, there was speculation about full legalization and quick passage of the Safe Banking Act. When that didn't happen, we saw the public market valuations of the cannabis operators decline significantly, and their access to equity capital was either cut off or suddenly became much more expensive. This environment of uncertainty was exacerbated by inflationary pressures, such as COVID, Ukraine, and the global supply disruption, as well as the Federal Reserve's actions. What's important to remember is that these operators are in growth mode. The demand for their products has shown no sign of letting up, not even through the pandemic when it actually accelerated, and they need to invest in production, cultivation, and retail. That demand for capital can best be met by working with us. We don't thrive on the disruption in the public equity market, but it is clearly a net positive for us both near and long-term. Tony, why don't you take it from here?

Anthony Cappell, Chief Executive Officer

Thanks, John. Good morning, everyone. We've done exactly what we said we would do on our IPO roadshow last December. We focused on growing our pipeline, putting the IPO proceeds to work at yields and collateral coverage consistent with our existing portfolio, executing on that pipeline as expeditiously as possible, and building on the first mover advantage that John described earlier. Before I get into details on our execution during Q4 and to date in Q1, I'd like to spend a few moments on the key differentiators responsible for these results. It all starts with how we drive new loan originations. Across the Chicago Atlantic platform, we have seven investment professionals dedicated to new loan originations. We like to think that we are responsible for bringing the normal structure of credit lending to the cannabis world. Most of our cannabis-focused competition sources their deals syndicated by investment banks or, in some cases, participates in facilities we lead. Other lenders or community banks might have a local relationship with an operator, but typically they won't have the cannabis experience to truly understand what they're underwriting or what their borrower needs. In addition to inbound referrals due to the brand recognition we've established, we also get referrals from borrowers, brokers, and banking relationships. When we're looking at new borrowers and loan opportunities, we focus on four criteria. The first is the state. As John noted earlier, our focus is primarily east of the Mississippi. This will continue to be our focus, but we are not precluded from making loans to the best-in-class operators in the more efficient markets. Second, we look for a medical state versus an adult-use state as a transition to adult-use creates revenue growth and consequently EBITDA growth, improving the creditworthiness of our borrower and improving the value of the underlying license and business. Third, we focus on cash flow. While all, but a small number of our loans have underlying coverage through real estate, we underwrite our borrowers on their ability to drive the bottom line and operate profitably. Lastly, we look for strong collateral coverage, which includes real estate, accounts receivable, equipment, personal guarantees, and other assets that may be more intangible in nature. We don't want to share too much of our secret sauce, but we have proprietary methods of perfecting collateral and liens in an industry where there are limitations when having to exercise your rights and remedies in a workout. Fortunately, we have not had that experience to date as all loans are performing and we have yet to have a payment default across the platform. But we do regularly underwrite that risk and have strong real estate coverage, equity pledges in all asset liens backing our loans. A great example of one of the closings in Q1 is our credit facility to Sanctuary Medicinals, which is a vertically integrated operator in Florida. This is a $25 million senior secured delay draw term loan that was used to build additional canopy and continue their dispensary expansion. As of close, they had six dispensaries open and expect to open an additional ten through the first year of the term. This is a great loan because first, they are based in Florida, a limited licensed state, with one of the most robust medical programs in the country. There are over 675,000 registered patients, and that continues to grow. Also, Florida is expected to transition to adult-use within the next few years, creating one of the largest markets in the U.S. because of the growing population and robust tourism market. Second, we have over two times real estate coverage today. If you include all the collateral, our estimated loan-to-value would be under 35%. Third, Sanctuary Medicinals has a great management team with a proven track record operating cannabis businesses. Lastly, all of their capital is used for accretive reasons which adds to our collateral and future cash flows of the borrower and mitigates risk throughout the term. Another key differentiator is that we structure our loans to be the borrower's only source of debt, and the REIT is the lead or co-lead on the credit facility. That protects our collateral and allows us to maintain a great relationship with our borrowers and grow with them. We also don't retrade, which is unique in an industry where that is common practice. The term sheets we provide are what we deliver. We believe that reputation combined with our large dedicated presence in the space, and the ability to grow with our borrowers, makes us the lender of choice for leading cannabis operators. One of the best measures of our reputation is the fact that our loan origination pipeline remains robust. Today, our pipeline is approximately $979 million in size, comprised of opportunities with both existing and potential borrowers in the limited license states. These opportunities have commensurate risk profiles and yields that comprise the existing portfolio. Through last week, we have completed nearly $115 million in loan fundings in the REIT since the IPO. That’s quite a start to our new life as a public company, and we look to build on that momentum. Looking ahead to the balance of the year, while we're not providing a specific loan origination target for 2022 at this time, I would note that this is largely a function of our access to attractive sources of capital. $115 million in the REIT in a little over three months is a strong pace, but we are sensitive to fueling that pace with capital that would dilute our existing investors. Andreas will walk through our capital plan shortly, but we expect to adhere to the plan we described in our IPO of utilizing the credit facility and possibly a debt offering before we come back to the public equity markets. Another promise we made during the IPO that we've delivered on is providing dividend growth to our investors. We declared our first dividend at year-end for Q4 of $0.26 per share, which was covered by adjusted distributable earnings, and even adjusting for the fully loaded share count of 17.5 million. As noted in our earnings release this morning, the Board has declared a Q1 dividend of $0.40 per share, a 54% increase from Q4, based on Friday's closing price that would equate to an annualized yield of 9.4%. While we have not stated a specific payout target, we expect it to be at least 85%. Now, Andreas will walk us through our investments and capital plan.

Andreas Bodmeier, Co-President and Chief Investment Officer

Thanks, Tony. Good morning. We did a good job of outlining our investment activity in the earnings release and supplemental documents. I'll reference both documents and provide some additional commentary. At our IPO, we disclosed a portfolio of 17 loans totaling $192 million in commitments, both funded and unfunded, producing a weighted average yield of 17.1%. By December 31, that portfolio had grown to total loan commitments of $235 million across 21 portfolio companies, with a weighted average yield of 18.6%. That internal rate of return was a little higher than expected due to a high-yielding bridge loan that preceded a larger facility in January 2021. As of March 17, our total loan commitments had grown to $324 million across 23 portfolio companies with a weighted average yield of 17.3%. That figure is more consistent with our expectations going forward. Recapping what we've done since the IPO, that equates to $115 million of total loan fundings from both new and existing commitments. Quite a start, but we have much more we want to accomplish. Our portfolio continues to be strong. All loans are current and performing. As we know, the Fed has been raising rates, which was a hot topic just last week. I would highlight that our portfolio is currently 57% floating rate, so we've been able to manage the impact of rising rates. As John noted earlier, the current environment hasn't diminished the demand for debt capital. In fact, it has increased it, and we feel comfortable that we will continue to source new opportunities that provide the yields that we've been targeting. We've also considered how inflation and rising interest rates might impact our borrowers. We've seen through our borrowers a 10% to 30% increase in construction costs and ongoing delivery delays. We have an experienced real estate and cannabis development team that evaluates our borrowers' construction efforts and underwrite such that our capital is insulated from construction execution risk. We believe that rising construction costs increase the value of our existing real estate collateral. For the industry, a rising interest rate environment demands a focus on underwriting to cash flow generation, which ultimately benefits conservatively leveled and established operators. Lastly, I'd like to talk about our capital plans for the year. Now that we have fully deployed our IPO proceeds, our next step is consistent with what we've described at our IPO. We plan to utilize our senior bank credit facility. In mid-December, we upsized our facility from $10 million to $45 million with another bank joining the facility. Although we currently have full availability on the existing line, we are in active negotiations to upsize it again over the next few weeks. The upcoming and future upsizes to the credit facility should provide us the runway needed to continue capturing new opportunities from our pipeline. Our goal has been to use this facility and possibly a bond offering to reach our target of only half a turn of leverage by year-end. We are conservative by nature and intend to run with lower leverage than is common in the mortgage REIT industry while remaining sensitive to the dilution of our current shareholders. With that, I'll turn it over to Lindsay to discuss our financials.

Lindsay Menze, Chief Financial Officer

Thanks, Andreas, and good morning everyone. First, I would call your attention to the supplemental information filed earlier today, which provides more detailed disclosures in addition to those referenced in these prepared remarks. With less than one month of actual operations as a public entity, the Q4 results aren't yet indicative of our potential performance, but were consistent with what we anticipated in our S11. The activities since the closing of our IPO have set us up well to deliver even better results over the course of the year. Rather than reading out all of the financial results this morning, I want to highlight a few moving parts in our Q4 print. As I noted earlier, we experienced significant growth in our loan portfolio during the quarter, especially in December as we began deploying the IPO proceeds. As such, our total interest income of $5.8 million doesn't yet reflect full deployment. We're well ahead of schedule on deployment of the IPO proceeds with an increasing benefit in Q1 and the full effect expected to show in Q2. Total expenses for the quarter were nearly equivalent to what we incurred for the year, as we recorded management fees for the first time, as well as approximately $63,000 of organizational expenses and $148,000 for CECL reserves, both of which were added back in our calculation of adjusted distributable earnings. Organizational expenses were lower than anticipated. Going forward, we expect G&A to be in the range of $2.5 million to $3 million as we are growing faster than expected. Given that our 10-K won't be filed until the 31st with footnotes to describe it, I'll provide some detail on the CECL reserves. Pursuant to ASC 326, we recorded a $148,000 provision for current expected credit losses in Q4. In determining this reserve, we noted that 92% of the portfolio is fully secured by real estate and 8% has limited or no real estate collateral. Our portfolio on average had real estate collateral coverage of 2.2 times as of December 31, 2021. All of our loans are secured by equity pledges of the borrower and all asset liens. After factoring in these items, as well as other adjustments defined in our S11, our adjusted distributable earnings per share was $0.61 for Q4. Our weighted average share count for Q4 reflected only 21 days of the impact from the IPO shares. During Q1, we will see most of the impact of the 17.8 million shares outstanding post-offering and post-greenshoe exercise in January 2022. Our book value as of December 31 was $15.13 per common share. Operator, we are now ready to take questions.

Operator, Operator

Thank you. Our first question is from Aaron Hecht with JMP Securities.

Aaron Hecht, Analyst

Good morning everyone. Congrats on the first earnings call and thanks for taking my questions. Tony, you said the payout ratio for the first quarter, the $0.40 dividend would be at least 85%. What metrics are you using for the denominator? Are we talking GAAP earnings, distributable, and is that including or excluding incentive fees if you're using distributable?

Anthony Cappell, Chief Executive Officer

Aaron, the 85% or higher is relative to distributable earnings, and that's the outlook for the year. For Q1, we paid out essentially 100%, but you would expect that number to be lower going forward.

Aaron Hecht, Analyst

Okay, and then the distributable are you, is that before or after incentive fees?

John Mazarakis, Executive Chairman

Andreas, can you hear me?

Andreas Bodmeier, Co-President and Chief Investment Officer

It's before incentive fees.

Aaron Hecht, Analyst

Before incentive fees, okay. And then secondly on the leverage talked about going to half a turn. If you get past that, what would you look at first after that? Would you prefer to look at the equity markets? Would you be willing to go to a higher leverage? How would you think about your capital options at that time?

Andreas Bodmeier, Co-President and Chief Investment Officer

We're seeing a lot of interest in our bank credit facilities. If we're able to grow that over $100 million, then opportunistically consider a bond offering, we may be above the half a turn of leverage temporarily, before we come back to the equity markets, which would then bring it back down to our target ratio.

Aaron Hecht, Analyst

Okay. And then last one, if I may. Yields on the signed term sheets what does that profile look like?

Anthony Cappell, Chief Executive Officer

So yield, we haven't seen any yield compression. There are sort of two buckets of loans that we're dealing with. The one bucket reflects the heavily brokered deals, the top 5 to 10 MSOs. And then, where we focus our bread and butter is mostly in the single state, dual state operators that have been doing a great job with plenty of collateral and cash flow. We continue to focus on those operators, and we haven't really seen any compression in rates currently.

Aaron Hecht, Analyst

Great, I appreciate that, John. Great job so far, guys. I'll jump back in the queue.

Operator, Operator

Thank you. Next question is from Mark Smith with Lake Street Capital.

Mark Smith, Analyst

Hi guys, I wanted to talk first just a little bit about the industry. You talked about limited license states and primarily focused east of the Mississippi, can you just talk about industry trends that you're seeing primarily in the markets that you operate?

Andreas Bodmeier, Co-President and Chief Investment Officer

So one anticipated event that we're all looking forward to is New Jersey going Rec. That has been something we've been looking forward to. Other trends are reflected in Massachusetts and Michigan, where we see slight compression. I would say that those are sort of markets that don't reflect the limited nature of other eastern states. In those markets, we're focusing on the top-tier operators that have targeted their cost per pound, and that has been our strategy.

Mark Smith, Analyst

Okay, and then you guys were talking about it here just a minute ago, but just talk about yield to maturity as we look through the year at 17.3, would you expect some compression over time or in a rising rate environment with that move higher? Maybe talk just big picture how you view that this year?

Andreas Bodmeier, Co-President and Chief Investment Officer

Yes, no, I would say that right now they're going to be consistent for quite some time. With the majority being over half of our loans are floating rate, you'll see a pickup there. In the medium-term and longer-term, I would expect there would be compression, but at least for the foreseeable future, in the existing pipeline it's commensurate with what we have in the portfolio.

Mark Smith, Analyst

Perfect. And then the last one from me, just as we think about growth in the portfolio through the rest of the year, can you talk about your mix or maybe expected mix of new borrowers versus kind of existing relationships?

Andreas Bodmeier, Co-President and Chief Investment Officer

So we have about $40 million in future fundings through existing facilities, and we have about $115 million in our underwriting pipeline with signed term sheets and deposits. We expect those ratios to sort of remain the same.

Mark Smith, Analyst

Great. Thank you, guys.

Andreas Bodmeier, Co-President and Chief Investment Officer

Thank you.

Operator, Operator

Thank you. I'm not showing any further questions in the queue, sir. I will turn the call back to John Mazarakis for his final thoughts.

John Mazarakis, Executive Chairman

Thank you, and thank you all for joining us this morning. We are available for follow-up questions. Thanks again.

Operator, Operator

And with that, ladies and gentlemen, we conclude today's conference. Thank you for your participation and you may now disconnect.